Cameron, Inc. is a U.S.-based exporting firm that expects to receive payments from sales denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $300,000 U.S. for the euros and $700,000 U.S. for the Canadian dollars. Based on data for the last fifty months, Cameron estimates the standard deviation of monthly percentage changes to be 10 percent for the euro and 5 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.48. Assuming that on average, the currencies appreciate each month; 0.12 % percent per month for the euro and 0.15% per month for the Canadian dollar. This means average return due to currency fluctuations is 0.12% for euro, and 0.15% for Canadian dollar. ( please show full operations )
1) Describe why holding a portfolio of two foreign currencies with a correlation coefficient of 0.92 could be considered high risk.
2) What is the expected % rate of return on the euro for the next month? How much is that in US dollars?
3) What is the expected % rate of return on the Canadian dollar for the next month? How much is that in US dollars.
4) What is the expected % return on the portfolio in the next month?
5) What is the portfolio's standard deviation?
6) What is the maximum one-month loss of the currency portfolio? State % and US dollars?
7) What is the portfolio standard deviation if the correlation coefficient changes to 0.80?
8) What is the new maximum one-month loss of the currency portfolio? State % and US dollars.
Hint: Use a Z factor based on 95 percent confidence level and assume the probability of the monthly percentage changes for each currency are normally distributed.